China has been working to promote the internationalization of its currency, the renminbi (RMB), for many years and the effort has escalated since the start of the 2008 global financial crisis. China’s motivation for pursuing this initiative appears to be the country’s desire to make the RMB the world’s next global reserve currency. The effects of this initiative are starting to be felt in a variety of ways by companies that do business in the country, China-based partners and China itself.

Impact on Companies Doing Business in China
In July 2013, the People’s Bank of China (PBOC) simplified RMB cross-border business processes to make these transactions easier for corporations as they adopt RMB for current and capital account usage:

Support of document checking is no longer a SAFE regulatory requirement but is subject to the beneficiary bank’s discretion.

Offshore/onshore banks are permitted to perform RMB cross-border settlements on current accounts based on the principles of Know Your Customer (KYC), Know Your Business (KYB) and due diligence processes.

China is expected to increase pressure on onshore counterparties to adopt RMB for global trade to reach its aggressive targets. As China’s RMB internationalization initiative progresses, most predict its share of trade invoicing will double to around 28 percent (or over $3 trillion) by 2020. Invoicing China’s global commodity trade in RMB alone will significantly accelerate internationalization, as nearly one-third of the country’s imports are commodity-based. It’s estimated that 6 percent of China’s commodity trade will be denominated in RMB by 2020.

As for RMB payments, offshore corporates can now do business with a broader base of companies in China and usually enjoy discounted local currency pricing schedules. Larger companies can also actively hedge their RMB exposures from a global perspective, diversifying their assets and, ultimately incorporate the RMB into their risk management programs.

Impact on China’s Economy
While internationalization carries with it many long-term benefits, such as increased prestige and influence and improved trade efficiencies, there are downsides as well. China’s currency reforms have always avoided opening up the country to external global shocks and have been designed to mitigate any loss of control over its domestic monetary policies, not to mention other domestic and foreign policy tradeoffs.

The RMB’s use in trade settlements has steadily increased since 2008 but is still very small compared to the size of the Chinese economy. U.S. dollars remain the preferred invoicing currency for the bulk of Chinese trade transactions, with the mismatch generating an actual increase in China’s foreign exchange reserves and deepening China’s dependence on and exposure to the U.S. dollar.

In terms of the net effect of RMB policy changes over the last several years, the RMB accounts for less than 1 percent of the average daily turnover in global currency markets according to the Bank of International Settlements. The international payments system SWIFT recently announced that the RMB was used in only 0.3 percent of global payments.

Most believe China is likely to enact more FX reform to avoid the volatility typical of internationalization as we’ve seen in the past with the euro and the yuan. While the RMB remains moderately undervalued, consensus is that the rate of appreciation is slowing. Beginning the week of March 17, 2014, the width of the daily trading band for onshore trading of the RMB was doubled to +/- 2 percent. The PBOC has expressed its intention of maintaining its currency at a “reasonable balanced level,” so there’s no reason to expect significant movement in the near future. Before the yuan can truly float on its own, rather than through government manipulation, China will have to restructure its interest rate system, which currently is also managed by the state with little maneuverability, range and market liquidity.

China's acceleration of the free-floating approach could create new challenges. The traditional strategy of raising interest rates to support the currency could possibly slow investment and growth, reducing GDP. But if the yuan becomes too expensive too quickly, it could hinder export growth, which has insulated China from the worldwide recession of the last several years and is considered the country’s economic lifeline. China’s growth has in fact slowed to 7.7 percent in the first quarter of 2014. Given its export-driven economy, the country is unlikely to relinquish full control of its currency in the short term.

In summary, while China is already considered a major economic power and is fully integrated in the global trade markets, the total percentage of trade settled in RMB remains small. Ever-mindful of the benefits of achieving reserve status for it currency and financial system, China’s regional—and, ultimately, international—approach to change can best be described as “crossing the river by feeling the stones.”…slow and steady progress. Let’s hope in the end this strategy will result in the RMB truly becoming the next major global currency.

Key Currencies

GBP – The pound fell about 1.5 percent from the start of March, but recovered most of the losses to close out the month almost flat. The bounce up was attributed to a better report on retail sales. Other economic data were consistent with estimates, including CPI YoY of 1.7 percent and GDP YoY of 2.7 percent.

EURO – The euro closed near the low for the month, as the ECB reiterated its pledge to hold the benchmark rate at an accommodative level until growth strengthens further. Inflation remains relatively benign with CPI YoY at 0.7 percent and GDP YoY still flat at 0.5 percent. The EUR fell about 1 percent for March.

CAD – The Canadian loonie was down 1.6 percent before recovering all of its losses for March. Weaker commodity prices drove traders to sell the currency, but a surprising upside report on retail sales helped to erase the loss and the CAD ended the month on a strong note.

JPY – Of the G10, the Japanese yen was certainly one of the more volatile currencies during the month. It rallied almost 2 percent as traders looked for a safer haven after weak trade and industrial production numbers coming out of China. The BOJ, however, repeated its commitment to maintain the current level of QE and the yen slumped to end the month essentially unchanged.

ZAR – Volatility was definitely a theme with the South African rand over the last month. The currency fell 1.5 percent, but then rebounded back 3 percent towards the end of March. Like the CAD, the rand was affected by weaker commodity prices before making a strong run against the dollar.

INR – Among the emerging market currencies, the Indian rupee was one of the strongest performers in March. The rupee rallied 3.1 percent and closed out the month on a high note. With continued government support and strong capital inflow into local equities, the currency breached the 60 mark and hit a six month high.

The views expressed in this column are solely those of the author and do not reflect the views of SVB Financial Group, or Silicon Valley Bank, or any of its affiliates. This material, including without limitation the statistical information herein, is provided for informational purposes only. The material is based in part upon information from third-party sources that we believe to be reliable, but which has not been independently verified by us and, as such, we do not represent that the information is accurate or complete. The information should not be viewed as tax, investment, legal or other advice nor is it to be relied on in making an investment or other decisions. You should obtain relevant and specific professional advice before making any investment decision. Nothing relating to the material should be construed as a solicitation or offer, or recommendation, to acquire or dispose of any investment or to engage in any other transaction.

Foreign exchange transactions can be highly risky, and losses may occur in short periods of time if there is an adverse movement of exchange rates. Exchange rates can be highly volatile and are impacted by numerous economic, political and social factors, as well as supply and demand and governmental intervention, control and adjustments. Investments in financial instruments carry significant risk, including the possible loss of the principal amount invested. Before entering any foreign exchange transaction, you should obtain advice from your own tax, financial, legal and other advisors, and only make investment decisions on the basis of your own objectives, experience and resources.

Currency RatesEconomic Matrix Key Currencies China has been working to promote the internationalization of its currency, the renminbi (RMB), for many years and the effort has escalated since the start of the 2008 global financial crisis. China’s motivation for pursuing this initiative appears to be the country’s desire to make the RMB the world’s next global reserve currency. The effects of this initiative are starting to be felt in a variety of ways by companies that do business in the country, China-based partners and China itself.

Impact on Companies Doing Business in China In July 2013, the People’s Bank of China (PBOC) simplified RMB cross-border business processes to make these transactions easier for corporations as they adopt RMB for current and capital account usage:

Corporations can undertake RMB cross-border payment and collection activity with simplified supporting documents.Wire transfers only require beneficiary bank instructions and the related...Read More